Investment Highlights

• Brent crossed the threshold US$40/barrel on Opec+ quota extension and rising China demand. Over the weekend, Opec+ decided to extend production quotas at almost the same level for another month instead of tapering them as planned by the end of June this year. Together with China's crude demand rebounding to 13mil barrels/day, Saudi Arabia has substantively raised prices for crude exports, the highest increase over 20 years.

Saudi Aramco raised Arab Light to Asia by an average US$6.10/barrel to a premium of 20 US cents over the benchmark, with all July grades to Asia by between US$5.60 and US$7.30/barrel. As a comparison, a Bloomberg survey of traders indicates an earlier expectation for an average increase of US$4/barrel. Saudi Arabia sells its crude at a differential to oil benchmarks by announcing the discount or premium charged to global refiners every month. These official selling prices set the direction in the physical oil market.

This has spurred Brent oil prices over the threshold US$40/barrel to US$43/barrel currently vs. future prices that had astonishingly fell to -US$38/barrel on 20 April this year. Overall, the increases for Saudi crude erased almost all of the discounts that were made during the price war with Russia which started briefly in March this year.

• Raise 2020 oil price forecast to US$40–US$45/barrel from US$35–40/barrel. YTD, Brent crude oil prices have averaged US$41/barrel while the current spot price has recovered to US$43/barrel from the year-low of US$14/barrel on 22 April 2020. Hence, while US crude oil inventories remain high at 534mil barrels (24% YoY), we have raised our crude oil price forecast to US$40–US$45/barrel from US$35–US$40/barrel for 2020, while maintaining US$45–US$50/barrel for 2021. For comparison, the EIA’s Short-Term Outlook projects crude oil price at US$34/barrel for 2020 and US$48/barrel for 2021.

• National oil companies may still reduce capex. Even though a measure of optimism has returned for crude oil prices, we expect oil producers to proceed with their planned production cuts for this year given that demand globally remains depressed amid the prolonged Covid-19 movement restrictions and social distancing measures across the world. Petronas, which had earlier indicated intentions to maintain domestic capex, has announced cuts of 21% for capital and 12% operating expenditure this year. This is similar to the 20% to 30% capex reductions for 2020 which were earlier announced by Exxon Mobil, Royal Dutch Shell, Saudi Aramco and Petrobras. In 1Q2020, the new contract awards to Malaysian operators dropped 74% QoQ and 70% YoY to RM569mil, with the worst fallout yet to come in 2Q2020 onwards.

• Most upstream service providers will be impacted. We maintain our view that most participants in the sector, except those in storage and recurring maintenance services, will be adversely impacted. Those with upstream production-sharing contracts such as Sapura Energy and Hibiscus Petroleum will suffer from lower prices and offtake, followed by fabricators such as MMHE and offshore support providers Bumi Armada and Velesto Energy. However, the earnings of service providers involved in maintenance and tank storage facilities such as Dialog Group and Serba Dinamik will be resilient against the cyclical nature of industry dynamics.

• Caution warranted on high gearing companies. Against the backdrop of a sharp demand drop in upstream oil services, we remain cautious on companies with high gearing levels. Excluding impairments and one-off adjustments, Sapura Energy registered a negative EBITDA of RM651mil, breaching net debt/EBITDA debt covenants for its RM10bil loans which need to be refinanced by the end of this year.

However, the rest of the players are relatively comfortable at this juncture as Serba Dinamik has recently raised a 10% equity placement while Bumi Armada has reclassified a RM1.3bil short-term debt to long term. While there is a risk that Velesto could reverse to a loss in 2HFY20 due to lower rig utilisation, its gross cash position should be able to meet its debt obligations for this financial year.

• Upgrade the sector to NEUTRAL from UNDERWEIGHT given the resumption of some optimism to the sector while our SELL calls have moderated. We have just added Petronas Chemicals Group, which has a high correlation to oil price direction, to our BUYs together with Dialog Group and Serba Dinamik Holdings. Nevertheless, as we continue to view the still low oil prices and earnings of upstream service companies to be worse than the previous 2015–2017 down-cycle which led to multiple financial distress to O&G corporations, we retain our SELL calls on Bumi Armada, Sapura Energy and Velesto Energy.

Source: AmInvest Research - 9 Jun 2020